What would a Corbyn government do to the gilt market?

Press Release
| Kames Capital

A Jeremy Corbyn government post the next general election has the
potential to send gilt yields soaring. Markets fear the worst over spending and
nationalisation plans, but that outcome is far from clear, according to Kames
Capital.

Some estimates put 10 year Gilt yields at 1.6% – almost double today’s yield
of 88bps. Policy makers led by Mark Carney have suggested base rates should be
higher than today’s 75bps. If base rates were up 25- 50bps higher expectations
are that would push Gilt yields higher. However, the recent rally in global
bond markets has pushed out expectations of UK rate rises.

Higher base rates and Gilt yields still seem a way off but UK politics
have been unprecedentedly volatile. So, Kames Capital’s fixed income managers
make the bull and bear case for the gilt market if we do indeed see a Corbyn
government occupying number 10 next.

Adrian Hull, head of fixed income, Kames Capital:

“Market’s do not like uncertainties. As outlined in insufficient detail,
the Labour Party’s spending and nationalisation policies could end up with a
few extra hundred billion of debt on the Bank of England’s balance sheet.

“Whilst it might be pointed out that the Bank already has £425bn of
Gilts, these were purchased from the market in return for cash for investment
elsewhere. The Labour Party has spending plans that will be materially beyond
that of the current budgetary balances, and further debt is likely to be issued
(or created at the Bank) due to nationalisation programmes.

“However, it is not so much the extra debt but rather the real concerns
over the coercive expropriation of assets that is being suggested. The bankrupt
Northern Rock model (as suggested by some politicians) is not a fair model to
repay investors in water companies, for example. It is this negative investment
backdrop which makes the 1.6% estimate for gilts look too low. Higher taxes
will slow growth but importantly those who can move assets and wealth out of
the UK will do so.

“This, along with reduced international confidence will see a weaker
pound and a reduction in appetite for UK assets – a reversal of the “kindness
of strangers” as Mark Carney noted in 2016. Indeed, as a reminder it was
only at the start of the year that Gilts were above 1.3% with a government
albeit ham-fistedly aiming to deliver a Brexit deal and some economic certainty.

Sandra Holdsworth, head of rates, Kames Capital:

“Despite concerns around the checks and balances of a future Labour
government there is no sign that the Labour party will aim to change the
independent status of the Bank of England that the Blair government established
in 1997 – indeed it was not a manifesto point in the 2017 election.

“The Labour Party’s plans will see an increase in debt but this should
also spur growth in an economy that is still below potential. Whilst some are
keen to talk about “un-costed” plans when it comes to Labour, recent comments
suggest planning around market responses. The elephant in the room remains the
low, no inflation environment that we are in globally. That and Trump’s trade
policies with China and Mexico have sent bond prices rocketing.
“With
core inflation in the US sinking to 1.5% and deflationary pockets in Europe
there remains more of a deflation than inflation risk. It’s difficult to see UK
yields move to 1.6% with this backdrop.”